Many of you downloaded our Vintage Funds Guide 2024 in recent days – if you didn’t, go here. There is also a new blog here which interprets this years Guide, which is always a big favourite. Do let us have your feedback if you find a moment over the long weekend.
Humility is important when investing, so is not getting over-excited. Lately I might have sounded encouraged by the fact that major stock markets, led by the US, do appear set for new peaks this Autumn, just as projected in the Spring. But those new peaks are not far ahead, and the vulnerabilities which have been behind the volatility of recent years have not abated. Let’s look at both of these angles.
I regularly focus on the S&P 500 not only because it is the primary US stock market index, but also because it is difficult for many global markets to make progress if this index is under pressure.
Some basic Elliott wave analysis projects a possible peak just ahead of 5744, a little over 2% above where it sits today. If it turns down at that point I admit I will be worried. Hope is not an investment strategy, yet I hope it does break above that level. Yes of course there is a valuation bubble and an investor mania, and the downside is horrible… but this index needs to reach levels above 5744 to drag other stock markets up with it.
If this US index only has 2% of momentum left, this should be sufficient for the FTSE 100 to get to a new high. But all bets are off for the FTSE 250 and FTSE SmallCap, at least for a little while. I have to be honest.
What about that vulnerability? The 40 year uptrend ended with a degree of complacency and recklessness (e.g. zero interest rates) that sowed the seeds for a volatile and occasionally ugly transition. Eventually that transition will end in a reset. Extremes will be more than eliminated e.g. the US stock market will go from irrational mania to equally irrational panic. There is no reversion to mean or the average. There is no “mean” in human mood with the onset of extreme uncertainty - just panic. The great news is that midst that panic there will be extraordinary opportunities. We must remain patient.
Zero rates were pivotal in creating an inherently unstable financial infrastructure. In recent weeks we saw how zero rates were the fuel for massive speculation in the Japanese stock market. Separately, we have highlighted for months the so-called yen carry trade i.e. vast sums borrowed in yen to “invest” in other currencies – this one is very far from over. The risks derived from the “shadow banks” are also beginning to emerge – more on that another week.
Another feature of this period, from 2008, has been the rise of the dollar. As global cash flooded the US markets it pushed the dollar higher and higher. That dollar bull run ended in 2022, and the adjustment was particularly notable in recent weeks as the yen finally began to fight back, causing the flash crash earlier in August, as explained here.
Currencies are notoriously difficult to figure. Nonetheless, I will put my head on the block. Basic technical analysis projects another 10% of downside in the dollar just ahead, which equates to about 90 on the dollar index (DXY).
There are lots of reasons why that downward pressure on the dollar might be a multi-year feature. Sharp rate cuts would hit the dollar. But this is only likely with a pronounced recession risk, and that simply isn’t there, not at the moment. Perhaps more likely is foreign investors taking profits in the Magnificent 7 and US Treasuries – when they repatriate their cash this hurts the dollar.
If dollar weakness persists it is good to understand how this might impact your investing:
- Asian markets are attractive, equities and bonds…
… debt denominated in dollars becomes easier to service.
- Emerging markets should be bought, equities and bonds. Historically, there has been a very high inverse correlation between the dollar and emerging market equities.
- Commodities will benefit, including commodity equities. Raw materials, which are priced in dollars, become more affordable to foreign buyers when the dollar declines.
- Gold in particular has an inverse correlation with the dollar i.e. they have a tendency to move in opposite directions.
- Higher yielding equities will be attractive as dollar interest rates fall.
But don’t over-do it. There is considerable complexity from week to week, and many variables. For example, if Trump gets elected and ramps up tariffs on Chinese imports it will give a new fillip to inflation, and a new upward bias to rates.
Ironically after recent events, Japanese equities do appear to be a decent option assisted by a weaker dollar, and stronger yen.
By 1989 the bubble and mania in Japanese equities had made it the world’s biggest stock market, in excess of 40% of the world index. Today it is just 6% (compared to the US at 62%). That’s what happens when you get a reset.
With the era of negative Japanese interest rates now coming to an end, this will encourage banks and other institutions with large amounts of capital overseas to repatriate their money (this being part of the yen carry trade story). All good news for the yen and for overseas investors buying Japanese equities.
It is already well understood that Japanese equities are cheap, and that their authorities took steps to unlock their considerable value early in 2023, as we covered in Japan Blossoming – Fundamental Reforms. These reforms have now reached a very interesting stage, which I will cover in the next note because, as you read this, I am on a ferry to Ireland.
For now, writing this on Thursday, I note that China in the guise of the HK index has had a decent week with gains of 1%-plus. Whether it holds will be an interesting matter to address in coming weeks, similarly whether any positivity spreads to the online markets, the A shares. Beyond that it has been a welcome week of little note.
It is likely there will not be a Friday Note next week, but for some unexpected crisis requiring comment. Enjoy the Bank Holiday weekend.